The National Catholic Review

Sad? Unbelievable? Outrageous? Whatever one thinks about the recent bankruptcy filing by the Archiocese of Portland, Ore., it is certainly unprecedented. And it is taking the Catholic Church down an uncertain and uncharted legal path. Portland’s Archbishop John Vlazny has sought the protection of the federal bankruptcy system from the diocese’s creditors, including victims of sexual abuse by members of the clergy, while he attempts to work out a plan that will distribute church assets in an equitable manner. The church is seeking a corporate reorganization through a Chapter 11 bankruptcy, just as other financially ailing corporations like United Airlines and Enron have done.

Bankruptcy

There are two forms of bankruptcy, Chapter 7 liquidations and Chapter 11 reorganizations. In Chapter 7, the debtor gives up his assets to be sold, the money is divided among the creditors, and the debtor’s remaining financial obligations are cancelled. (In this description important exceptions are being ignored for the sake of simplicity.) A bishop would not file for a Chapter 7 liquidation. He does not want to sell church assets and go out of business. He wants to ensure that the church can continue to provide assistance to its members in their search for eternal life. In a Chapter 11 procedure, the debtor proposes a plan that will allow creditors to receive as much money as possible, cancel the remaining obligations and allow the debtor a reasonable likelihood of successfully continuing the enterprise. While its sounds illogical, one need not be insolvent (debts exceeding assets) to file bankruptcy.

In this case, the bishop has voluntarily entered bankruptcy. As an eleemosynary (charitable) institution, the church cannot be forced into bankruptcy. The voluntary nature of this legal action has, as we will later see, important legal repercussions.

A number of solvent corporations facing mass tort liability suits (as are some dioceses, because of the many sexual abuse cases) have sought Chapter 11 reorganization as a tactic to force a global settlement of all the litigation. That feature is quite attractive and is available because under the law all legal actions are consolidated in the bankruptcy court. But there are also many drawbacks.

Judicial Oversight

The debtor’s affairs are put under the control of the bankruptcy court. The creditors, who in this case include victims of sexual abuse, will play an active role as the court supervises the operations of the diocese. They will question the bishop about a wide range of matters and make inquiries of other church management personnel, comb through financial records looking for assets, seek to prevent preferential treatment of one group of creditors over others and search for impermissible transfers of assets by the bishop to other entities controlled by or friendly to him. They may also object to proposed future actions by the diocese. The bishop will be under the active supervision of the bankruptcy court and will need prior court approval for taking various actions. The court will undoubtedly authorize the bishop to continue engaging in routine financial matters, like writing checks to pay utility bills. But before writing a million-dollar check to fund expansion of a parish school, for example, he would need the judge’s permission. The creditors will be allowed to object and argue, if they wish, that the money should rightfully go to them instead.

A bishop, who enjoys unquestioned religious authority to administer his diocese as he sees fit, will probably not take kindly to such supervision by a judge and to relentless inquiries by the creditors. The process will be severely intrusive. The creditors can be expected to hire not just run-of-the-mill accountants, but forensic accountants who are skilled in tracing assets through highly complex series of transactions. Transactions will be viewed with a high level of skepticism and questioned accordingly to satisfy the auditors that the true purpose of each transaction is understood and is supported by a sound rationale. To emerge from bankruptcy, the diocese will have to propose a financial plan that fairly distributes its assets among its creditors (money will also be allocated for future claims by victims of sexual abuse), while permitting the church to operate successfully in the future. If this plan does not gain the approval of a majority of the different creditor groups, the judge is unlikely to approve it. In that situation, the creditors can propose their own plans for court approval.

Public Disclosure

Given the unusual nature of a church bankruptcy, the press will certainly provide extensive coverage. The United States does not have a secret judicial system. Judge’s decisions and the basis for them, court proceedings and documents are a matter of public record. This system is designed to prevent undue favoritism and conflicts of interest, and to discourage the paying of bribes to corrupt the judicial system. The church, and even some victims of sexual abuse, will probably petition the court to keep certain matters secret, to file them under seal. But the legal presumption is in favor of openness, and the press can oppose such a motion for secrecy. Furthermore, when the bankruptcy court is in session, it is expected to be open and allow matters discussed therein to be reported by the press or observed by any interested member of the public. This means that in Portland we will see, for the first time, full and complete disclosure of a Catholic diocese’s assets, liabilities and overall operations (with the exception of matters filed under seal).

Church-State Entanglements

The bankruptcy judge and creditors will have no interest in ecclesiastical decisions that lack important financial ramifications, like the appointment of an elementary school principal, whether or not a candidate is ready for ordination, or which priest is assigned to a particular parish. Judicial proceedings will therefore steer clear of such matters. But there remains the possibility of disputes between the bishop and the judge over the proper exercise of the bishop’s religious authority.

Let us consider the previous example of a bishop wishing to expend a million dollars on a school expansion project, for which the judge denies permission. The bishop might argue that since canon law grants him sole authority in such matters, the judge cannot interfere without violating the church’s free exercise of religion rights under the First Amendment. Two large legal obstacles may prevent the bishop’s argument from being successful. One is the fact that the bishop voluntarily placed the diocese in bankruptcy. Having done so, how credible would it be for him to complain that submission to a court order constitutes excessive entanglement of church and state?

Second, the United States Supreme Court has ruled in several instances that the First Amendment does not remove the obligation to comply with a valid and neutral law of general applicability on the ground that the law proscribes (or prescribes) conduct that one’s religion prescribes (or proscribes). These cases are more recent than the court’s decision in 1979 that the National Labor Relations Board could not mandate a bishop to bargain with teachers employed by a Catholic school. Bankruptcy law meets the definition of a valid and neutral law of general applicability. The Supreme Court has mandated that a civil court not substitute its judgment for that of a religion’s highest judicial body on matters of discipline, faith, internal organization, ecclesiastical rule, custom or law. But it has done so solely within the confines of disputes involving church members among themselves or between a local church and its national body. Such cases are the exact opposite of a church voluntarily seeking sanctuary within the civil law and then not agreeing with the result.

Church Structures

There are approximately 200 dioceses in the United States. Legally, therefore, there is not one Catholic Church in the United States, but rather almost 200 Catholic structures, plus hybrids like hospitals, religious orders and the like.

A Catholic diocese is likely to consist of various legal entities, and the organizational structure can vary from diocese to diocese. Different bishops have structured their dioceses differently. Just as in the secular world, where one corporation may own other separate corporations, called subsidiaries, a diocese may be the legal parent of other wholly owned not-for-profit entities. Some bishops favor simple diocesan structures, others work in complex organizational structures. It is believed that as the lawsuits over sexual abuse cases began to multiply in the last decade, several bishops began creating new corporate entities to hold the assets of newly formed parishes in order to shield them from liability from creditors.

An individual parish may be part of the diocese or it may be a separate legal entity. The distinction can be critical. If a parish is legally part of the diocese and the diocese is liable for a debt, the parish’s assets can be used to satisfy that debt. But if the parish is a separate entity, its assets cannot be seized to pay the debt of the diocese. For the same reason, diocesan fund-raising may be done through a separate legal foundation, for instance, and a different corporation may own real estate assets.

In corporation law, however, there is the concept of disregarding the corporate entity or piercing the corporate veil, which allows a court to hold one entity responsible for the actions of another related entity, where they have not been operated independently. Considering the influence and power a bishop has, the creditors will certainly explore in the bankruptcy proceedings whether these church entities are separate in name only, or truly operate as independent bodies.

This exploration of the Archdiocese of Portland’s legal structures by the creditors, in the hope of gaining access to assets the bishop argues belong to an entity that is not in bankruptcy, will consume a great deal of time and hold the greatest potential for constitutional litigation.

Financial Dimensions

If, in fact, the Archdiocese of Portland lacks the money to compensate its creditors 100 cents on the dollar, the creditors must make do with less. This frequently occurs in bankruptcy. Unlike Jesus, who multiplied loaves and fishes, a bishop cannot command the appearance of increased financial resources. The archdiocese claims it has already paid out more than $53 million to settle other cases and says the bankruptcy filing was precipitated by two plaintiffs seeking in excess of $160 million. The Archdiocese of Boston paid out $21 million between 1994 and 2001 and a further $85 million in 2004. Chicago paid $16.8 million between 1993 and 2003 and an additional $4 million in mid-2003. Dallas paid almost $12 million in the late 1990’s. These are just a few samples to indicate the amounts involved. It is truly tragic that the church has missed so many opportunities for service because of the need to pay these many victims. The moral failure of a handful of bishops is responsible for harm of indefinable dimensions.

While certainly a delicate question, and one that is awkward for the church to pose, should not society ask whether it is necessary to award such gargantuan dollar amounts in order to compensate victims fairly? Does $5 million or $10 million added to an already generous award really make an individual whole again? Another impolitic question is this: If the attorney is representing the victim on a contingent-fee basis (that is, the lawyer is paid a percentage of the amount recovered, typically 25 percent to 40 percent), are proposed settlements being declined simply because the lawyer thinks the church is rich and has more monies available?

But instead of considering these questions, juries may feel that as long as the bishops fail to condemn the few among them who sheltered the predatory pedophiles and the pope takes such actions as rewarding Cardinal Law with a position at the Vatican, they should award victims huge amounts of money in order to punish the church.

On the other hand, one positive development likely to spring from Portland’s bankruptcy is that it should make victims and their attorneys more realistic in their financial demands. Previously, the threat of bankruptcy was thought to be just a bluff. Now, when a bishop uses that word, it will carry more credibility. The old saying that a bird in the hand is worth two in the bush applies here. Acceptance of an equitable settlement can be preferable to making an excessive damage claim that causes a bankruptcy, which in turn can lead to years expending additional time and resources. In the end, far less money will be available to creditors, because the debtor will have dissipated its assets litigating the bankruptcy action.

First or Last?

Is the bankruptcy of the Archdiocese of Portland only the first, with more to come? That will depend to a large extent on what happens in this case. If the bankruptcy proceeds relatively fast (30 to 36 months), if the creditors are not unduly hostile to the bishop and each other (which is not to say the struggle will not be contentious and hard-fought), if the claimants moderate their financial expectations and if the bishop does not find the judge and creditors excessively challenging of his religious authority, the successful bankruptcy proceeding of this archdiocese could lead other bishops to make the same decision as Archbishop Vlazny.

But if the bankruptcy leads to an all-out legal war between the sexual abuse victims and the bishop that drags on for six or seven years, and if the judge treads frequently and deeply into areas where canon law says only a bishop has authority, this could generate continuing bad press for the church.The public may perceive it all as no more than the use by the church of a legal loophole to avoid its moral obligation to victims. If this turns out to be the case, the bankruptcy of the Archdiocese of Portland may well be a one-time experiment.

Fred J. Naffziger is an attorney and professor of business law at Indiana University, South Bend, Ind.

Comments

Matthias Neuman O.S.B. | 8/3/2004 - 10:55am
I enjoyed very much the article, "An Uncertain Path," by Fred J. Naffziger (8/2). It pointed out very well what a significant step the declaration of bankruptcy by a diocese may mean. Nothing less than a whole new era of Church-State relations for the Catholic Church in the United States.

But I have a question for Prof. Naffziger, an issue he did not broach in the article. Would the condition of bankruptcy have any impact on labor relations within the diocese? For example, if the teachers of Catholic schools in the diocese decided to unionize, would bankruptcy court have any say in that matter?

Matthias Neuman, O.S.B. | 2/9/2007 - 4:50pm
I enjoyed very much “An Uncertain Path,” by Fred J. Naffziger (8/2). It pointed out very well what a significant step the declaration of bankruptcy by a diocese may be: nothing less than a whole new era of church-state relations for the Catholic Church in the United States.

But I have a question for Professor Naffziger, an issue he did not broach in the article. Would the condition of bankruptcy have any impact on labor relations within the diocese? For example, if the teachers of Catholic schools in the diocese decided to unionize, would a bankruptcy court have any say in that matter?

Matthias Neuman O.S.B. | 8/3/2004 - 10:55am
I enjoyed very much the article, "An Uncertain Path," by Fred J. Naffziger (8/2). It pointed out very well what a significant step the declaration of bankruptcy by a diocese may mean. Nothing less than a whole new era of Church-State relations for the Catholic Church in the United States.

But I have a question for Prof. Naffziger, an issue he did not broach in the article. Would the condition of bankruptcy have any impact on labor relations within the diocese? For example, if the teachers of Catholic schools in the diocese decided to unionize, would bankruptcy court have any say in that matter?